Friday, 8 February 2008

Can offshoring create domestic jobs?

Outscourcing has been a major concern all around the world in recent years. Here in New Zealand Alliance Party president Victor Billot is reported to have said,

... a manufacturing policy had to be introduced that stopped the bleed of skills and jobs to low wage economies, which had to include tariff and other support for producers, and disincentives for outsourcing and relocating corporates.

In the US Alan Blinder warn that about the social affects of outscouring,

massive transformations in the nature of work tend to bring wrenching social changes in their wake.

Mankiw and Swagel noted that in the runup to the 2004 US election,

outscourcing became synonymous in the public debate with job loss

Is there any basis for such concerns?

This CEPR Policy Insight outlines empirical research that looks at the effects of outscouring on the Japanese domestic labour market. The research on which the policy Insight is based is

Ando, M. and F. Kimura (2007), 'International Production/ Distribution Networks and Domestic Operations in Term of Employment and Corporate Organization: Microdata Analysis of Japanese Firms,' September, Keio University mimeograph.

First note that theoretically the effect of offshore outsourcing on domestic operations may be positive or negative. The outcome depends on whether the cost savings from offshoring make the firm more competitive, inducing it to expand at home, and whether the activities abroad are complementary to domestic operations.

To see what the actual effects of outscouring where for the Japanese labour market data from a comprehensive survey of firms with more than 50 workers or capital exceeding 30 million yen conducted by the Japanese government's Ministry of Economy, Trade, and Industry for fiscal years 1998 - 2003 was studied. The firms in the data set primarily offshore to East Asia.

A cursory examination of the data suggests that domestic employment is not reduced by offshoring. While the majority of firms in the survey cut jobs between 1998 and 2003, those expanding their operations in East Asia did so much less than those that did not. For example manufacturing firms going abroad for the first time averaged domestic employment growth of 9.1% and firms expanding their offshoring only cut domestic employment by 2.2%. In contrast, manufacturing firms with no change in their offshore presence reduced domestic employment by more than 5%, and those reducing their East Asian operations cut jobs by more than 10%.

Overall the data suggests that at the firm level pursuing foreign direct investment (FDI) in East Asia is associated with positive affects on employment, establishments and affiliates in the home market, Japan.

When econometric methods are applied to the data they demonstrate that the correlation noted above holds when the authors control for other variables, such as firm size, capital-intensity, the ratio of foreign to domestic sales, research and development activity, advertising expenditures, and foreign capital holding the firm. For manufacturing firms, expansion of operations in East Asia is associated with no decline in domestic employment. The analysis by Ando and Kimura also shows no statistically significant relationship between the expansion of manufacturing operations in East Asia and a decline in the number of domestic establishments or affiliates. They note, importantly, that domestic and foreign operations appear to be complements, not substitutes.

As to why this is the case Ando and Kimura point out that growth in manufacturing operations in East Asia and grow in domestic employment may reflect a need to expand domestic production of key parts and components exported to East Asia or an intensified specialisation in headquarters services at home as a result of fragmentation of production. It is also be possible that globalising manufacturing firms succeed in differentiating products produced in the domestic market from those produced elsewhere in East Asia.

It is also noted by Ando and Kimura that the positive impacts on domestic employment due to globalising manufacturing activities grow over time.

While expanding operations abroad are correlated with a 3% increase in domestic employment over a one year horizon, they are associated with an 8% increase over a five year period, compared with others.

In summary,

The statistics and our formal analysis both suggest that globalising manufacturing firms are less likely to reduce their domestic employment than other firms. In fact, controlling for other firm characteristics, they experience greater job creation at a rate as high as 8%.

3 comments:

So the question is whether offshoring causes protection of local jobs, and if so why?

It could be a selection bias: firms going offshore are systematically more efficient and have the know how it takes to succeed off shore. These are the firms that survive. If this is true, then offshoring is correlated with greater know how/efficieny, which in turn is correlated with survival in the market and job protection. Off shoring per se does not protect jobs.

What's another hypothesis. That going offshore lowers costs, and thus improves the firm's survival. But this doesn't explain why it maintains a local manufacturing base in greater numbers than firms that do not off shore. off shoring itself must grant some kind of knowledge or skills advantage the firm applies locally to keep workers productive and employable.

It can't be the first idea alone. Even if firms are efficient there must be a reason they offshore, that reason I would think is they become even more efficient. Thus I think both the first and second ideas have a role.

Ando and Kimura make the point "The domestic employment expansion by Japanese manufacturing firms with growing operations in East Asia may reflect a need to expand domestic production of key parts and components exported to East Asia or an intensified specialisation in headquarters services at home as a result of fragmentation of production. An alternative explanation may be that globalising manufacturing firms succeed in differentiating products produced in the domestic market from those produced elsewhere in East Asia."

So you may offshore the things that overseas production has a comparative advantage in and keep at home the bits that home has a comparative advantage in. If total production goes up, home production goes up. And/or if you can price discriminate between home and foreign then you may expand production at home as it is more profitable.

The CEPR policy insight draws a long bow from the data in the Ando and Kimura report in my opinion.

Firstly it is a relatively short term study - five years. Outsourcing off shore would be expected to lead to growth onshore initially due to the double ups required to set up off shore at the same time as continuing to fill orders locally. I notice that firms expanding their offshore operations, as opposed to setting up were downsized their staff locally by 2%

Secondly there may well be a causal relationship between one firm outsourcing offshore and the demise of other firms who continue to produce locally. If outsourcing off shore is being done to produce cheaper goods then local firms are not going to be able to compete and may well have to downsize their staff in greater numbers.

Mr Billot is talking in terms of New Zealand where without a doubt the removal of import restrictions and tariffs in the 1980's and 90's led to wholesale outsourcing/ importing to countries where good could be produced much more cheaply (albeit under very poor working conditions in many cases) decimated many local industries. Footwear, apparel, textile to name a few. Unemployment rose dramatically and wages for production and service workers dropped to below a liveable level.

If one looks at the wider picture I consider Mr Billot and Mr Blinder are right.